Next crisis: Credit Default Swaps

[FRED]

Part I


Part II

Hat tip to member Rajiv!

[zoog]

Re: Next crisis: Credit Default Swaps

Thanks that was informative. I've probably just missed it before but I now learned that the CDS "insurance" could be purchased without actually owning the underlying asset being insured. As the video said, like buying insurance on someone else's house that you know is sitting on a fault line. And no limits on how many people can buy insurance on that house. Thus, if the bond or whatever goes bust... the potential payouts could be many times more than the value of the underlying asset.

[Rajiv]

Re: Next crisis: Credit Default Swaps

Part 2 (7 min)

Above

[Sapiens]

Re: Next crisis: Credit Default Swaps

LOL, the naive think the CDS are about buying or selling protection or even gambling. What no one is willing to say is that they are about not paying any taxes. Yawn.

[Rajiv]

Re: Next crisis: Credit Default Swaps

From Credit Default Swaps: An Introduction

Hedging and Speculation
CDS have the following two uses.

• A CDS contract can be used as a hedge or insurance policy against the default of a bond or loan. An individual or company that is exposed to a lot of credit risk can shift some of that risk by buying protection in a CDS contract. This may be preferable to selling the security outright if the investor wants to reduce exposure and not eliminate it, avoid taking a tax hit, or just eliminate exposure for a certain period of time. (For more on hedging your investments, read Practical And Affordable Hedging Strategies and Corporate Use Of Derivatives For Hedging.)
  
  
• The second use is for speculators to "place their bets" about the credit quality of a particular reference entity. With the value of the CDS market, larger than the bonds and loans that the contracts reference, it is obvious that speculation has grown to be the most common function for a CDS contract. CDS provide a very efficient way to take a view on the credit of a reference entity. An investor with a positive view on the credit quality of a company can sell protection and collect the payments that go along with it rather than spend a lot of money to load up on the company's bonds. An investor with a negative view of the company's credit can buy protection for a relatively small periodic fee and receive a big payoff if the company defaults on its bonds or has some other credit event. A CDS can also serve as a way to access maturity exposures that would otherwise be unavailable, access credit risk when the supply of bonds is limited, or invest in foreign credits without currency risk.